CSPI- 10Q 2014.3.31

United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q 
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended
March 31, 2014
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             .
 
Commission File Number 0-10843
 
 
CSP Inc.
(Exact name of Registrant as specified in its Charter)
 

Massachusetts
04-2441294
(State of incorporation)
(I.R.S. Employer Identification No.)
 
43 Manning Road
Billerica, Massachusetts 01821-3901
(978) 663-7598
(Address and telephone number of principal executive offices)
 
 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x    No  o.
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o.
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
o
Accelerated filer
o
 
 
 
 
Non-accelerated filer
o (Do not check if a smaller reporting company)
Smaller reporting company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
 
As of May 14, 2014, the registrant had 3,588,641 shares of common stock issued and outstanding.

1


INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CSP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except par value) 
 
March 31,
2014
 
September 30,
2013
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
12,860

 
$
18,619

Accounts receivable, net of allowances of $309 and $242
22,418

 
13,529

Inventories, net
6,464

 
4,791

Refundable income taxes
577

 
624

Deferred income taxes
1,144

 
1,313

Other current assets
2,578

 
2,042

Total current assets
46,041

 
40,918

Property, equipment and improvements, net
1,491

 
1,420

 
 
 
 
Other assets:
 

 
 

Intangibles, net
610

 
410

Deferred income taxes
1,677

 
1,771

Cash surrender value of life insurance
2,645

 
2,481

Other assets
226

 
225

Total other assets
5,158

 
4,887

Total assets
$
52,690

 
$
47,225

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued expenses
$
13,366

 
$
10,503

Deferred revenue
6,334

 
3,816

Pension and retirement plans
760

 
746

Income taxes payable
1

 
60

Total current liabilities
20,461

 
15,125

Pension and retirement plans
8,690

 
8,660

Other long term liabilities
424

 
405

Total liabilities
29,575

 
24,190

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Shareholders’ equity:
 
 
 
Common stock, $.01 par value per share; authorized, 7,500 shares; issued and outstanding 3,589 and 3,496 shares, respectively
36

 
35

Additional paid-in capital
11,301

 
11,137

Retained earnings
17,489

 
17,728

Accumulated other comprehensive loss
(5,711
)
 
(5,865
)
Total shareholders’ equity
23,115

 
23,035

Total liabilities and shareholders’ equity
$
52,690

 
$
47,225

See accompanying notes to unaudited consolidated financial statements.

3


CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except for per share data)

 
For the three months ended
 
For the six months ended
 
March 31,
2014
 
March 31,
2013
 
March 31,
2014
 
March 31,
2013
Sales:
 
 
 
 
 
 
 
Product
$
14,319

 
$
19,537

 
$
29,068

 
$
34,842

Services
6,584

 
6,286

 
13,167

 
11,851

Total sales
20,903

 
25,823

 
42,235

 
46,693

 
 
 
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
Product
11,639

 
15,676

 
24,222

 
28,900

Services
4,153

 
4,380

 
8,231

 
7,849

Amortization of inventory step-up and intangibles
29

 

 
167

 

Total cost of sales
15,821

 
20,056

 
32,620

 
36,749

 
 
 
 
 
 
 
 
Gross profit
5,082

 
5,767

 
9,615

 
9,944

 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Engineering and development
792

 
380

 
1,427

 
824

Selling, general and administrative
3,957

 
4,165

 
7,977

 
7,725

Total operating expenses
4,749

 
4,545

 
9,404

 
8,549

 
 
 
 
 
 
 
 
Bargain purchase gain on acquisition, net of tax

 

 
462

 

 
 
 
 
 
 
 
 
Operating income
333

 
1,222

 
673

 
1,395

 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
Foreign exchange gain (loss)
(27
)
 
(8
)
 
(53
)
 
5

Other income (expense), net
(21
)
 
(17
)
 
(21
)
 
29

Total other income (expense), net
(48
)
 
(25
)
 
(74
)
 
34

Income before income taxes
285

 
1,197

 
599

 
1,429

Income tax expense
118

 
457

 
86

 
574

Net income
$
167

 
$
740

 
$
513

 
$
855

Net income attributable to common stockholders
$
161

 
$
724

 
$
495

 
$
838

Net income per share – basic
$
0.05

 
$
0.21

 
$
0.14

 
$
0.25

Weighted average shares outstanding – basic
3,446

 
3,375

 
3,439

 
3,369

Net income per share – diluted
$
0.05

 
$
0.21

 
$
0.14

 
$
0.25

Weighted average shares outstanding – diluted
3,493

 
3,424

 
3,484

 
3,416

 
See accompanying notes to unaudited consolidated financial statements.

4


CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)

 
 
For the three months ended
 
For the six months ended
 
 
March 31,
2014
 
March 31,
2013
 
March 31,
2014
 
March 31,
2013
 
 
 
 
 
 
 
 
 
Net income
 
$
167

 
$
740

 
$
513

 
$
855

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Foreign currency translation gain (loss) adjustments
 
4

 
(72
)
 
154

 
(16
)
Other comprehensive income (loss)
 
4

 
(72
)
 
154

 
(16
)
Total comprehensive income
 
$
171

 
$
668

 
$
667

 
$
839


See accompanying notes to unaudited consolidated financial statements.


5


CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
For the Six Months Ended March 31, 2014:
(Amounts in thousands, except per share data)
 
 
Shares
 
Amount
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
other
comprehensive
loss
 
Total
Shareholders’
Equity
Balance as of September 30, 2013
3,496

 
$
35

 
$
11,137

 
$
17,728

 
$
(5,865
)
 
$
23,035

Net income

 

 

 
513

 

 
513

Other comprehensive income

 

 

 

 
154

 
154

Exercise of stock options
1

 

 
6

 

 

 
6

Stock-based compensation

 

 
158

 

 

 
158

Restricted stock issuance
92

 
1

 

 

 

 
1

Cash dividends on common stock ($0.21 per share)

 

 

 
(752
)
 

 
(752
)
Balance as of March 31, 2014
3,589

 
$
36

 
$
11,301

 
$
17,489

 
$
(5,711
)
 
$
23,115

 
See accompanying notes to unaudited consolidated financial statements.

6


CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
 
For the six months ended
 
March 31,
2014
 
March 31,
2013
Cash flows from operating activities:
 
 
 
Net income
$
513

 
$
855

Adjustments to reconcile net income to net cash used in operating activities:
 

 
 

Bargain purchase gain
(462
)
 

Depreciation and amortization
245

 
213

Amortization of intangibles
60

 
41

Loss (gain) on sale of fixed assets, net
2

 
(15
)
Foreign exchange (gain) loss
53

 
(5
)
Non-cash changes in accounts receivable
67

 
5

Non-cash changes in inventory
140

 

Stock-based compensation expense on stock options and restricted stock awards
159

 
67

Deferred income taxes
21

 
27

Increase in cash surrender value of life insurance
(84
)
 
(45
)
Changes in operating assets and liabilities:
 

 
 

Increase in accounts receivable
(8,763
)
 
(8,339
)
Decrease in officer life insurance receivable

 
2,172

(Increase) decrease in inventories
(764
)
 
1,731

Decrease in refundable income taxes
476

 
7

Increase in other current assets
(503
)
 
(838
)
(Increase) decrease in other assets

 
(74
)
Increase (decrease) in accounts payable and accrued expenses
2,676

 
(285
)
Increase in deferred revenue
2,445

 
601

Decrease in pension and retirement plans liability
(120
)
 
(130
)
Increase (decrease) in income taxes payable
(486
)
 
209

Increase in other long term liabilities
19

 
20

Net cash used in operating activities
(4,306
)
 
(3,783
)
Cash flows from investing activities:
 

 
 

Life insurance premiums paid
(80
)
 
(196
)
Proceeds from the sale of fixed assets
6

 
17

Cash paid to acquire business
(500
)
 

Purchases of property, equipment and improvements
(295
)
 
(476
)
Net cash used in investing activities
(869
)
 
(655
)
Cash flows from financing activities:
 

 
 

Dividends paid
(752
)
 
(689
)
Proceeds from issuance of shares from exercise of employee stock options
6

 

Net cash used in financing activities
(746
)
 
(689
)
Effects of exchange rate on cash
162

 
(75
)
Net decrease in cash and cash equivalents
(5,759
)
 
(5,202
)
Cash and cash equivalents, beginning of period
18,619

 
20,493

Cash and cash equivalents, end of period
$
12,860

 
$
15,291

Supplementary cash flow information:
 

 
 

Cash paid for income taxes
$
63

 
$
336

Cash paid for interest
$
85

 
$
85

 
 
 
 
 See accompanying notes to unaudited consolidated financial statements.

7


CSP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTHS ENDED MARCH 31, 2014 AND 2013

 
Organization and Business
 
CSP Inc. was founded in 1968 and is based in Billerica, Massachusetts. To meet the diverse requirements of its industrial, commercial and defense customers worldwide, CSP Inc. and its subsidiaries (collectively “CSPI” or the “Company”) develop and market IT integration solutions and high-performance cluster computer systems. The Company operates in two segments, its High Performance Products and Solutions segment and its Information Technology Solutions segment.
 
1.         Basis of Presentation
 
The accompanying consolidated financial statements have been prepared by the Company, without audit, and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the results of the interim periods presented. All adjustments were of a normal recurring nature. Certain information and footnote disclosures normally included in the annual financial statements, which are prepared in accordance with accounting principles generally accepted in the United States, have been condensed or omitted. Accordingly, the Company believes that although the disclosures are adequate to make the information presented not misleading, the unaudited financial statements should be read in conjunction with the footnotes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2013.
 
2.        Use of Estimates
 
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates under different assumptions or conditions.
 
3.  Acquired Business  

On November 4, 2013 the Company acquired substantially all of the assets of Myricom, Inc.  Myricom has been integrated into the High Performance Products and Solutions business segment.  Prior to our acquisition, Myricom was a manufacturer of high performance interconnect computing devices and software.  The Company acquired Myricom in order to obtain (i) Myricom’s interconnect technology, which is critical to our latest MultiComputer products and (ii) a strong base of new customers in commercial growth markets.  The Company also retained key Myricom technical personnel.  Myricom was a key supplier to CSPI’s MultiComputer Division.  Its interconnect technology is an important component of the latest generation MultiComputer products that we currently supply to our customers.

Although Myricom was an established business prior to our acquisition, it had previously sold off a significant portion of its business and was faced with the likelihood of having to shut down operations if it could not find a buyer to purchase its remaining assets.  This was because the revenue that Myricom was able to generate from these remaining assets was not sufficient to support its cost structure so as to enable Myricom to operate at a profit.  These factors contributed to a purchase price that resulted in the recognition of a bargain purchase gain.  The Company paid total cash consideration of approximately $0.5 million to acquire substantially all of the assets of Myricom and incurred approximately $0.1 million for the assumption of certain other liabilities.  The purchase of Myricom resulted in the recognition of a bargain purchase gain of approximately $0.5 million.  The bargain purchase gain is shown net of the federal and state tax effect.

 
The purchase price was allocated as follows:

8


 
(Amounts in Thousands)
Inventory
$
1,030

Property & equipment
17

Intangibles
260

Gross assets acquired
1,307

Product warranty liability assumed
(93
)
Net assets acquired
1,214

Less: asset purchase price
500

Bargain purchase gain before tax
714

Deferred tax on bargain purchase gain
(252
)
Bargain purchase gain, net of tax effect
$
462

The results of operations of Myricom for the the three months ended March 31, 2014 and for the period November 4, 2013 - March 31, 2014 are included in the Company’s consolidated statement of operations for the three and six months ended March 31, 2014, respectively.

The following proforma condensed combined financial information gives effect to the acquisition of Myricom as if it were consummated on October 1, 2012 (the beginning of the comparable prior reporting period), and includes proforma adjustments related to the bargain purchase gain, amortization of inventory step-up and acquired intangible assets. The proforma condensed combined financial information is presented for informational purposes only. The proforma condensed combined financial information is not intended to represent or be indicative of the results of operations that would have been reported had the acquisition occurred on October 1, 2012 and should not be taken as representative of future results of operations of the combined company.
The following table presents the proforma condensed combined financial information (in thousands, except per share amounts):
 
For the three months ended
 
For the six months ended
 
March 31, 2014
 
March 31, 2013
 
March 31, 2014
 
March 31, 2013
 
(Amounts in thousands except per share data)
Revenue
$
23,236

 
$
27,477

 
$
45,187

 
$
50,224

Net income (loss)
$
198

 
$
(31
)
 
$
224

 
$
(865
)
Net income (loss) per share – basic
$
0.06

 
$
(0.01
)
 
$
0.07

 
$
(0.25
)
Net income (loss) per share – diluted
$
0.06

 
$
(0.01
)
 
$
0.07

 
$
(0.25
)

The proforma condensed combined financial information shown above includes proforma adjustments to eliminate certain items directly relating to the business combination which reduced net income by approximately $0.3 million for the six month period ended March 31, 2014.
 

4.        Earnings Per Share of Common Stock
 
Basic net income per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted net income per common share reflects the maximum dilution that would have resulted from the assumed exercise and share repurchase related to dilutive stock options and is computed by dividing net income by the assumed weighted average number of common shares outstanding.
 
We are required to present earnings per share, or EPS, utilizing the two class method because we had outstanding, non-vested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents, which are considered participating securities.
 

9


Basic and diluted earnings per share computations for the Company’s reported net income attributable to common stockholders are as follows:

 
For the three months ended
 
For the six months ended
 
March 31, 2014
 
March 31, 2013
 
March 31, 2014
 
March 31, 2013
 
(Amounts in thousands except per share data)
Net income
$
167

 
$
740

 
$
513

 
$
855

Less: net income attributable to nonvested common stock
6

 
16

 
18

 
17

Net income attributable to common stockholders
$
161

 
$
724

 
$
495

 
$
838

 
 
 
 
 
 
 
 
Weighted average total shares outstanding – basic
3,580

 
3,448

 
3,562

 
3,437

Less: weighted average non-vested shares outstanding
134

 
73

 
123

 
68

Weighted average number of common shares outstanding – basic
3,446

 
3,375

 
3,439

 
3,369

Potential common shares from non-vested stock awards and the assumed exercise of stock options
47

 
49

 
45

 
47

Weighted average common shares outstanding – diluted
3,493

 
3,424

 
3,484

 
3,416

 
 
 
 
 
 
 
 
Net income per share – basic
$
0.05

 
$
0.21

 
$
0.14

 
$
0.25

Net income per share – diluted
$
0.05

 
$
0.21

 
$
0.14

 
$
0.25

 
All anti-dilutive securities, including certain stock options, are excluded from the diluted income per share computation. For the three months ended March 31, 2014 and 2013, 49,000 and 183,000 options, respectively, were excluded from the diluted income per share calculation because their inclusion would have been anti-dilutive as their exercise price exceeded fair value. For the six months ended March 31, 2014 and 2013, 49,000 and 190,000 options, respectively, were excluded from the diluted income per share calculation because their inclusion would have been anti-dilutive as their exercise price exceeded fair value.

5.         Inventories

Inventories consist of the following:
 
March 31, 2014
 
September 30, 2013
 
(Amounts in thousands)
Raw materials
$
2,559

 
$
1,587

Work-in-process
796

 
404

Finished goods
3,109

 
2,800

Total
$
6,464

 
$
4,791

 
Finished goods includes inventory that has been shipped, but for which all revenue recognition criteria has not been met, of approximately $0.3 million and $0.5 million as of March 31, 2014 and September 30, 2013, respectively.
 
Total inventory balances in the table above are shown net of reserves for obsolescence of approximately $4.5 million and $4.6 million as of March 31, 2014 and September 30, 2013, respectively.
 

6.        Accumulated Other Comprehensive Loss
 

10


 The components of accumulated other comprehensive loss are as follows:

 
 
March 31, 2014
 
September 30, 2013
 
 
(Amounts in thousands)
Cumulative effect of foreign currency translation
 
$
(2,002
)
 
$
(2,156
)
Cumulative unrealized loss on pension liability
 
(3,709
)
 
(3,709
)
Accumulated other comprehensive loss
 
$
(5,711
)
 
$
(5,865
)


7.         Pension and Retirement Plans
 
The Company has defined benefit and defined contribution plans in the United Kingdom, Germany and the U.S. In the United Kingdom and Germany, the Company provides defined benefit pension plans and defined contribution plans for the majority of its employees. In the U.S., the Company provides benefits through supplemental retirement plans to certain current and former employees. The domestic supplemental retirement plans have life insurance policies which are not plan assets but were purchased by the Company as a vehicle to fund the costs of the plan. Domestically, the Company also provides for officer death benefits through post-retirement plans to certain officers.  All of the Company’s defined benefit plans are closed to newly hired employees and have been for the two years ended September 30, 2013 and for the six months ended March 31, 2014.

The Company funds its pension plans in amounts sufficient to meet the requirements set forth in applicable employee benefits laws and local tax laws. Liabilities for amounts in excess of these funding levels are accrued and reported in the consolidated balance sheets.
 
Our pension plan in the United Kingdom is the only plan with plan assets. The plan assets consist of an investment in a commingled fund which in turn comprises a diversified mix of assets including corporate equity securities, government securities and corporate debt securities.
 
The components of net periodic benefit costs related to the U.S. and international plans are as follows:
 
 
For the Three Months Ended March 31,
 
2014
 
2013
 
Foreign
 
U.S.
 
Total
 
Foreign
 
U.S.
 
Total
 
(Amounts in thousands)
Pension:
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
12

 
$

 
$
12

 
$
15

 
$

 
$
15

Interest cost
193

 
17

 
210

 
173

 
16

 
189

Expected return on plan assets
(117
)
 

 
(117
)
 
(104
)
 

 
(104
)
Amortization of:
 

 
 

 
 

 
 

 
 

 
 

Prior service gain

 

 

 

 

 

Amortization of net gain
23

 
(2
)
 
21

 
36

 
6

 
42

Net periodic benefit cost
$
111

 
$
15

 
$
126

 
$
120

 
$
22

 
$
142

 
 
 
 
 
 
 
 
 
 
 
 
Post Retirement:
 

 
 

 
 

 
 

 
 

 
 

Service cost
$

 
$
2

 
$
2

 
$

 
$

 
$

Interest cost

 
11

 
11

 

 
9

 
9

Amortization of net gain

 
(36
)
 
(36
)
 

 
(46
)
 
(46
)
Net periodic benefit cost
$

 
$
(23
)
 
$
(23
)
 
$

 
$
(37
)
 
$
(37
)

11



 
For the six Months Ended March 31,
 
2014
 
2013
 
Foreign
 
U.S.
 
Total
 
Foreign
 
U.S.
 
Total
 
(Amounts in thousands)
Pension:
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
23

 
$

 
$
23

 
$
30

 
$

 
$
30

Interest cost
383

 
34

 
417

 
346

 
32

 
378

Expected return on plan assets
(232
)
 

 
(232
)
 
(208
)
 

 
(208
)
Amortization of:
 
 
 
 
 
 
 
 
 
 
 
Prior service gain

 

 

 

 

 

Amortization of net gain
46

 
(4
)
 
42

 
72

 
12

 
84

Net periodic benefit cost
$
220

 
$
30

 
$
250

 
$
240

 
$
44

 
$
284

 
 
 
 
 
 
 
 
 
 
 
 
Post Retirement:
 

 
 

 
 

 
 

 
 

 
 

Service cost
$

 
$
5

 
$
5

 
$

 
$

 
$

Interest cost

 
22

 
22

 

 
18

 
18

Amortization of net gain

 
(72
)
 
(72
)
 

 
(92
)
 
(92
)
Net periodic benefit cost
$

 
$
(45
)
 
$
(45
)
 
$

 
$
(74
)
 
$
(74
)


12


8.        Segment Information
 
Beginning in the current period ended March 31, 2014, we have renamed our segments. We have renamed the segment that was formerly known as the Systems segment to the High Performance Products and Solutions segment. We have also renamed the segment that was formerly known as the Service and System Integration segment to the Information Technology Solutions segment.

The following table presents certain operating segment information.
 
 
 
 
Information Technology Solutions Segment
 
 
For the Three Months Ended March 31,
 
High Performance Products and Solutions
Segment
 
Germany
 
United
Kingdom
 
U.S.
 
Total
 
Consolidated
Total
 
 
(Amounts in thousands)
2014
 
 
 
 
 
 
 
 
 
 
 
 
Sales:
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
$
2,170

 
$
3,452

 
$
336

 
$
8,361

 
$
12,149

 
$
14,319

Service
 
1,065

 
4,486

 
304

 
729

 
5,519

 
6,584

Total sales
 
3,235

 
7,938

 
640

 
9,090

 
17,668

 
20,903

Income (loss) from operations
 
113

 
294

 
(30
)
 
(44
)
 
220

 
333

Assets
 
15,644

 
20,882

 
2,726

 
13,438

 
37,046

 
52,690

Capital expenditures
 
41

 
14

 
22

 
32

 
68

 
109

Depreciation and amortization
 
54

 
49

 
4

 
46

 
99

 
153

 
 
 
 
 
 
 
 
 
 
 
 
 
2013
 
 

 
 

 
 

 
 

 
 

 
 

Sales:
 
 

 
 

 
 

 
 

 
 

 
 

Product
 
$
2,494

 
$
3,794

 
$
110

 
$
13,139

 
$
17,043

 
$
19,537

Service
 
143

 
4,571

 
429

 
1,143

 
6,143

 
6,286

Total sales
 
2,637

 
8,365

 
539

 
14,282

 
23,186

 
25,823

Income (loss) from operations
 
149

 
368

 
(15
)
 
720

 
1,073

 
1,222

Assets
 
15,945

 
15,869

 
3,359

 
16,232

 
35,460

 
51,405

Capital expenditures
 
98

 
72

 
3

 
168

 
243

 
341

Depreciation and amortization
 
39

 
46

 
2

 
44

 
92

 
131


13


 
 
 
 
Information Technology Solutions Segment
 
 
For the six Months Ended March 31,
 
High Performance Products and Solutions
Segment
 
Germany
 
United
Kingdom
 
U.S.
 
Total
 
Consolidated
Total
 
 
(Amounts in thousands)
2014
 
 
 
 
 
 
 
 
 
 
 
 
Sales:
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
$
3,176

 
$
4,853

 
$
983

 
$
20,056

 
$
25,892

 
$
29,068

Service
 
2,348

 
8,674

 
632

 
1,513

 
10,819

 
13,167

Total sales
 
5,524

 
13,527

 
1,615

 
21,569

 
36,711

 
42,235

Income from operations
 
255

 
213

 
1

 
204

 
418

 
673

Assets
 
15,644

 
20,882

 
2,726

 
13,438

 
37,046

 
52,690

Capital expenditures
 
102

 
101

 
45

 
47

 
193

 
295

Depreciation and amortization
 
106

 
95

 
8

 
96

 
199

 
305

 
 
 
 
 
 
 
 
 
 
 
 
 
2013
 
 

 
 

 
 

 
 

 
 

 
 

Sales:
 
 

 
 

 
 

 
 

 
 

 
 

Product
 
$
2,590

 
$
5,858

 
$
264

 
$
26,130

 
$
32,252

 
$
34,842

Service
 
1,100

 
7,775

 
731

 
2,245

 
10,751

 
11,851

Total sales
 
3,690

 
13,633

 
995

 
28,375

 
43,003

 
46,693

Income (loss) from operations
 
(224
)
 
221

 
(15
)
 
1,413

 
1,619

 
1,395

Assets
 
15,945

 
15,869

 
3,359

 
16,232

 
35,460

 
51,405

Capital expenditures
 
139

 
127

 
6

 
204

 
337

 
476

Depreciation and amortization
 
76

 
88

 
7

 
83

 
178

 
254

Profit (loss) from operations consists of sales less cost of sales, engineering and development, selling, general and administrative expenses but is not affected by either non-operating charges/income or by income taxes. Non-operating charges/income consists principally of investment income and interest expense.  All intercompany transactions have been eliminated.
 
The following table lists customers from which the Company derived revenues in excess of 10% of total revenues for the three and six months ended March 31, 2014, and 2013.

 
 
For the three months ended,
 
For the six months ended
 
 
March 31, 2014
 
March 31, 2013
 
March 31, 2014
 
March 31, 2013
 
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
(dollars in millions)
Customer A
 
$
1.9

 
8
%
 
$
5.9

 
23
%
 
$
8.0

 
18
%
 
$
11.0

 
23
%
Customer B
 
$
5.6

 
27
%
 
$
4.8

 
18
%
 
$
8.9

 
21
%
 
$
7.4

 
16
%
Customer C
 
$

 
%
 
$
3.0

 
12
%
 
$

 
%
 
$
4.2

 
9
%

Accounts receivable from Customer B totaled approximately $12.8 million, which comprised 57% of total consolidated accounts receivable as of March 31, 2014, and $3.5 million, which comprised 26% of total consolidated accounts receivable as of September 30, 2013. We believe that the Company is not exposed to any particular credit risk with respect to the accounts receivable with this customer.


14


9.        Fair Value Measures
 
Assets and Liabilities measured at fair value on a recurring basis are as follows:
 
 
Fair Value Measurements Using
 
Level 1
 
Level 2
 
Level 3
 
Total
Balance
 
As of March 31, 2014
 
(Amounts in thousands)
Assets:
 
 
 
 
 
 
 
Money Market funds
$
1,005

 
$

 
$

 
$
1,005

Total assets measured at fair value
$
1,005

 
$

 
$

 
$
1,005

 
 
 
 
 
 
 
 

 
As of September 30, 2013
 
(Amounts in thousands)
Assets:
 

 
 

 
 

 
 

Money Market funds
$
3,503

 
$

 
$

 
$
3,503

Total assets measured at fair value
$
3,503

 
$

 
$

 
$
3,503

 
These assets are included in cash and cash equivalents in the accompanying consolidated balance sheets.  All other monetary assets and liabilities are short-term in nature and approximate their fair value. The Company did not have any transfers between Level 1, Level 2 or Level 3 measurements.
 
The Company had no liabilities measured at fair value as of March 31, 2014 or September 30, 2013. The Company had no assets or liabilities measured at fair value on a non recurring basis as of March 31, 2014 or September 30, 2013.
 
10.    Dividend
On December 17, 2013, our board of directors declared a cash dividend of $0.10 per share which was paid on January 7, 2014 to shareholders of record as of December 27, 2013, the record date.

On February 11, 2014, our board of directors declared a cash dividend of $0.11 per share which was paid on March 11, 2014 to shareholders of record as of February 27, 2014, the record date.

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements
 
The discussion below contains certain forward-looking statements related to, among others, but not limited to, statements concerning future revenues and future business plans. In addition, forward-looking statements include statements in which we use words such as “expect,” “believe,” “anticipate,” “intend,” or similar expressions. Although we believe the expectations reflected in such forward-looking statements are based on reasonable assumptions, we cannot assure you that these expectations will prove to have been correct, and  actual results may vary from those contained in such forward-looking statements.
 
Markets for our products and services are characterized by rapidly changing technology, new product introductions and short product life cycles. These changes can adversely affect our business and operating results. Our success will depend on our ability to enhance our existing products and services and to develop and introduce, on a timely and cost effective basis, new products that keep pace with technological developments and address increasing customer requirements. The inability to meet these demands could adversely affect our business and operating results.
 
Critical Accounting Policies
 
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our estimates, including those related to uncollectible receivables, inventory valuation, income taxes, deferred compensation and retirement plans, estimated selling prices used for revenue recognition and contingencies. We base our estimates on historical performance and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. A description of our critical accounting policies is contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013 in the “Critical Accounting Policies” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Results of Operations

Explanatory note

Beginning in the current period ending and as of March 31, 2014, we have renamed our segments. We have renamed the segment that was formerly known as the Systems segment to the High Performance Products and Solutions ("HPPS") segment. We have also renamed the segment that was formerly known as the Service and System Integration segment to the Information Technology Solutions ("ITS") segment.

Overview of the six months ended March 31, 2014 Results of Operations

Overview:

 Revenue decreased by approximately $4.5 million, or 10%, to $42.2 million for the six months ended March 31, 2014 versus $46.7 million for the six months ended March 31, 2013. Our gross profit margin percentage increased overall, from 21% for the six months ended March 31, 2013 to 23% for the six months ended March 31, 2014. Operating income decreased by $0.7 million to approximately $0.7 million for the six-month period ended March 31, 2014 versus $1.4 million for the six months ended March 31, 2013. This decrease in operating income was due to a decrease in gross profit of approximately $0.3 million, an increase in operating expenses of approximately $0.9 million, due in large part to the operating expenses of Myricom, partially offset by a bargain purchase gain of $0.5 million on the acquisition of Myricom, Inc. during the six months ended March 31, 2014. Net income was $0.5 million for six-month period ended March 31, 2014 versus $0.9 million for the six months ended March 31, 2013.


15


The following table details our results of operations in dollars and as a percentage of sales for the six months ended March 31, 2014 and 2013:
 
 
 
March 31, 2014
 
%
of sales
 
March 31, 2013
 
%
of sales
 
 
(Dollar amounts in thousands)
Sales
 
$
42,235

 
100
 %
 
$
46,693

 
100
%
Costs and expenses:
 
 

 
 

 
 

 
 

Cost of sales
 
32,620

 
77
 %
 
36,749

 
79
%
Engineering and development
 
1,427

 
3
 %
 
824

 
2
%
Selling, general and administrative
 
7,977

 
19
 %
 
7,725

 
16
%
Total costs and expenses
 
42,024

 
99
 %
 
45,298

 
97
%
Bargain purchase gain, net of tax
 
462

 
1
 %
 

 
%
Operating income
 
673

 
1
 %
 
1,395

 
3
%
Other income (expense)
 
(74
)
 
 %
 
34

 
%
Income before income taxes
 
599

 
1
 %
 
1,429

 
3
%
Income tax expense
 
86

 
 %
 
574

 
1
%
Net income
 
$
513

 
1
 %
 
$
855

 
2
%


Sales
 
The following table details our sales by operating segment for the six months ended March 31, 2014 and 2013:
 
 
 
HPPS
 
ITS
 
Total
 
% of
Total
 
 
(Dollar amounts in thousands)
For the Six Months Ended March 31, 2014:
 
 
 
 
 
 
 
 
Product
 
$
3,176

 
$
25,892

 
$
29,068

 
69
%
Services
 
2,348

 
10,819

 
13,167

 
31
%
Total
 
$
5,524

 
$
36,711

 
$
42,235

 
100
%
% of Total
 
13
%
 
87
%
 
100
%
 
 

 
 
 
HPPS
 
ITS
 
Total
 
% of
Total
For the Six Months Ended March 31, 2013:
 
 

 
 

 
 

 
 

Product
 
$
2,590

 
$
32,252

 
$
34,842

 
75
%
Services
 
1,100

 
10,751

 
11,851

 
25
%
Total
 
$
3,690

 
$
43,003

 
$
46,693

 
100
%
% of Total
 
8
%
 
92
%
 
100
%
 
 

 

16


 
 
HPPS
 
ITS
 
Total
 
%
increase (decrease)
Increase (Decrease)
 
 

 
 

 
 

 
 

Product
 
$
586

 
$
(6,360
)
 
$
(5,774
)
 
(17
)%
Services
 
1,248

 
68

 
1,316

 
11
 %
Total
 
$
1,834

 
$
(6,292
)
 
$
(4,458
)
 
(10
)%
% increase (decrease)
 
50
%
 
(15
)%
 
(10
)%
 
 

 
Total revenues decreased by approximately $4.5 million, or 10%, for the six months ended March 31, 2014 compared to the six months ended March 31, 2013.  Revenue in the HPPS segment increased for the current year six-month period versus the prior year six-month period by approximately $1.8 million, while revenues in the ITS segment decreased by approximately $6.3 million.
 
Product revenues decreased by approximately $5.8 million, or 17%, for the six months ended March 31, 2014 compared to the comparable period of the prior fiscal year. Product revenues in the ITS segment decreased by approximately $6.4 million while in the HPPS segment, product revenue increased by approximately $0.6 million for the six-month period ended March 31, 2014 versus the six month period ended March 31, 2013.

The increase in product revenues in the HPPS segment of approximately $0.6 million was due substantially to revenues from the acquisition of Myricom, Inc., which the Company acquired during the six months ended March 31, 2014. Myricom revenues for the period were approximately $2.5 million. Partially offsetting this increase, revenues from our Japanese defense customer, US defense customer and sales from the US PCDA division decreased by approximately $1.6 million, $0.2 million and $0.2 million, respectively.

In the US division of the ITS segment, product sales decreased by approximately $6.1 million, while product sales in the German and UK divisions of the segment increased by approximately $1.0 million, and $0.7 million, respectively.
 
In the US division's existing customer base, product sales in the IT Hosting vertical and the Education vertical decreased by approximately $4.7 million and $1.3 million, respectively. The decrease in the IT hosting vertical reflected decreased demand in this vertical. The decrease in the Education vertical reflected a non-recurring large project in the prior year.

In Germany, the $1.0 million decrease in product revenue was the result of decreased sales in the division’s telecommunications and cable operator verticals of approximately $0.1 million and $1.2 million, respectively partially offset by favorable foreign exchange fluctuation and $0.2 million. In the UK, the increase in product sales of approximately $0.7 million is attributable to increased sales resources focused on increasing product sales in that region.

Service revenues increased by approximately $1.3 million, or 11%.  This increase was made up of an increase in the HPPS segment of $1.2 million and an increase in the ITS segment of approximately $0.1 million. The increase in the HPPS segment service revenue was due to higher royalty income recorded in the six months ended March 31, 2014 which was approximately $1.9 million versus $0.8 million for the six months ended March 31, 2013.

The increase in service revenues in the ITS segment was due to an increase in the German division, where service revenue increased by approximately $0.9 million, partially offset by a decrease in service revenues of approximately $0.7 million in the US division. In Germany, the increase in service sales was made up of approximately $0.4 million from favorable foreign exchange, and increased service revenues in the division's telecommunications vertical of approximately $1.1 million. These increases were partially offset by decreased sales in the industrial and IT Services verticals of approximately $0.3 million and $0.2 million, respectively. The decrease in service revenue in the US division of the segment was primarily from lower professional service project revenue of approximately $0.3 million and lower third party maintenance revenue of approximately $0.3 million for the six months ended March 31, 2014 versus the six months ended March 31, 2013.
 
Our sales by geographic area, based on the location to which the products were shipped or services rendered, are as follows:
 

17


 
 
For the six months ended,
 
 
 
 
 
 
March 31, 2014
 
%
 
March 31, 2013
 
%
 
$ Increase
(Decrease)
 
% Increase
(Decrease)
 
 
(Dollar amounts in thousands)
Americas
 
$
26,425

 
63
%
 
$
29,689

 
64
%
 
$
(3,264
)
 
(11
)%
Europe
 
14,819

 
35
%
 
14,673

 
31
%
 
146

 
1
 %
Asia
 
991

 
2
%
 
2,331

 
5
%
 
(1,340
)
 
(57
)%
Totals
 
$
42,235

 
100
%
 
$
46,693

 
100
%
 
$
(4,458
)
 
(10
)%
 
The decrease in Americas revenue for the six months ended March 31, 2014 versus the six months ended March 31, 2013 was primarily the result of an overall decrease in sales to the Americas in the ITS segment where combined product and service sales to US customers decreased by an aggregate $6.2 million, while in the HPPS segment, sales to US customers to the Americas increased by approximately $2.9 million, which was driven by Myricom sales to US customers of approximately $2.0 million and the royalty sales increase of approximately $1.1 million, partially offset by lower product sales in the HPPS segment to other US customers. The change in sales into Europe was from an increase of approximately $0.5 million from the HPPS segment, attributable to Myricom sales, partially offset by a decrease in sales from the European divisions of the ITS segment of approximately $0.3 million. The decrease in Asia sales was the result of lower sales in the HPPS segment to our customer which supplies the Japanese Department of Defense.

18


Cost of Sales and Gross Margins

The following table details our cost of sales and gross profit margins by operating segment for the six months ended March 31, 2014 and 2013:

 
HPPS
 
ITS
 
Total
 
% of
Total
 
(Dollar amounts in thousands)
For the Six Months Ended March 31, 2014:
 
 
 
 
 
 
 
Product
$
1,919

 
$
22,303

 
$
24,222

 
74
 %
Services
94

 
8,137

 
8,231

 
25
 %
Amortization of inventory step-up and intangibles
167

 

 
167

 
1
 %
Total
$
2,180

 
$
30,440

 
$
32,620

 
100
 %
% of Total
7
 %
 
93
 %
 
100
 %
 
 

% of Sales
39
 %
 
83
 %
 
77
 %
 
 

Gross Margins:
 

 
 

 
 

 
 

Product
40
 %
 
14
 %
 
17
 %
 
 

Services
96
 %
 
25
 %
 
37
 %
 
 

Total
61
 %
 
17
 %
 
23
 %
 
 

 
 
 
 
 
 
 
 
For the Six Months Ended March 31, 2013:
 

 
 

 
 

 
 

Product
$
979

 
$
27,921

 
$
28,900

 
79
 %
Services
127

 
7,722

 
7,849

 
21
 %
Amortization of inventory step-up and intangibles

 

 

 
 %
Total
$
1,106

 
$
35,643

 
$
36,749

 
100
 %
% of Total
3
 %
 
97
 %

100
 %
 
 

% of Sales
30
 %
 
83
 %
 
79
 %
 
 

Gross Margins:
 

 
 

 
 

 
 

Product
62
 %
 
13
 %
 
17
 %
 
 

Services
88
 %
 
28
 %
 
34
 %
 
 

Total
70
 %
 
17
 %
 
21
 %
 
 

 
 
 
 
 
 
 
 
Increase (decrease)
 

 
 

 
 

 
 

Product
$
940

 
$
(5,618
)

$
(4,678
)
 
(16
)%
Services
(33
)
 
$
415

 
382

 
5
 %
Amortization of inventory step-up and intangibles
167

 
$

 
167

 
 %
Total
$
1,074

 
$
(5,203
)
 
$
(4,129
)
 
(11
)%
% Increase (decrease)
97
 %
 
(15
)%

(11
)%
 
 

% of Sales
9
 %